12 Jan Housing Rules Too Burdensome? Here’s A Real Fix.

Ben Carson, in testimony for his Senate confirmation Thursday, said onerous housing rules caused inequality because “the wealthy have their pick of loans” while “those without credit are locked out.”

Where have we heard this before?

In 2002, George Bush said, “We can put light where there’s darkness, and hope where there’s despondency in this country. And part of it is working together as a nation to encourage folks to own their own home.”

But, for the record, relaxation of mortgage underwriting in the run-up to the Credit Crisis made social inequality worse, by (a) encouraging predatory lending where our African American and Latin communities were targeted, and (b) causing losses of net worth in the form of home equity, sometimes leading to (c) loss of the home.

The real fix for inequality in the credit markets is to bring securitization back and improve transparency in secondary market performance.

That isn’t news. Moody’s research as early as 1995 shows a buildup of that capital in RMBS that is wasted if the structure is not made to release capital buildup. By inference, the capital is wasted when ratings don’t change.

What may be news is the mathematics behind this fix.

The magnitude of waste can be quantified: approximately 1/3rd the contingent capital allocated to each transaction. So, if a straight-up, no hanky-panky $1 BN RMBS transaction has 20% subordination-enough to cushion a pool of sincere borrowers who lack financial flexibility-a dynamic rating system could, over time, provide the justification for releasing 6.7%, of that 20%, or $67 MM. In a $20 TN securitization market, that’s as much as $1.34 TN of free cash for reinvestment in new loans, better education, increased consumption etc. That’s more than enough to test everyone’s pet theory on how to eradicate inequality and bring back some intangible quality of life in America.

In the late 1990s – early 2000s, when losses from global arbitrage trading made liquidity very expensive, banks responded by “releasing” redundant RMBS capital up front, before it was possible to prove the securities were properly capitalized. That was wrong. It led to a pattern of cashing out money that wasn’t in the collateral to begin with. The economy is still paying the price.

The real fix isn’t to strong-arm either side of the market into subsidizing bad behavior on the other side. The real fix is to let borrowers get capital the old fashioned way (earn it) by migrating our credit system to a modern ratings architecture that reflects creditworthiness without politics.